Revisiting Your ABCs

Do you believe in the random walk theory? Noted Princeton economist Burton Malkiel popularized the phrase with his book, A Random Walk Down Wall Street (1973), which went on to become a huge bestseller, and explains his ideas about investing and the stock markets. Approximately one year ago, a portfolio of 10 stocks with one-letter trading symbols between A-D, using the combination to demonstrate effective portfolio construction, whether random or not, was assembled. The man-made portfolio's three-year annualized rate of return between May 2005 and May 2008 was 13.84%, more than double the S&P 500 index. Now revisiting the ABCs, it is interesting how the haphazardly prepared portfolio is doing. (Read the aforementioned article, Invest In Your ABCs.)

Serious ShrinkageWhat do you know; the ABCs portfolio got absolutely hammered in the past 52 weeks, with no less than six of 10 stocks dropping by more than 50%, putting a severe dent in its now four-year performance.

Citigroup's 83% drop isn't the portfolios worst, but it's definitely the most prominent. Receiving $45 billion in bailout money and now 36%-owned by the U.S. government, no explanation is needed as to why owning the once-proud bank hurt the portfolio.

The worst drop, however, goes to

CircuitCity, the now-defunct electronics retailer. In March, Canadian telecom giant BCE Inc. (NYSE:BCE) acquired the assets of CircuitCity's Canadian subsidiary, The Source. CircuitCity paid $355 million in 2004 for Radio Shack's Canadian stores. BCE paid far less, although a specific price is unknown at this time. A couple of months later, Systemax, owner of TigerDirect.com bought CircuitCity's name and web site for $14 million. With the collapse complete, there was only $2,835.93 left to lose on a $10,000 investment. Here's to small miracles.

ABCs Portfolio (Almost Four Years)

May 27, 2005-May 22, 2009

Company

Value of $10,000 Initial Investment

Agilent Technologies (NYSE:A)

$11,905.87

Alcoa (NYSE:AA)

$2,806.77

Barnes Group (NYSE:B)

$13,157.21

Blackboard (Nasdaq:BBBB)

$19,348.70

Citigroup (NYSE:C)

$1,237.66

CircuitCity (OTC:CCTYQ.PK)

$0.00

Calgon Carbon (NYSE:CCC)

$12,609.58

Dominion Resources (NYSE:D)

$10,700.47

DuPont (NYSE:DD)

$6,062.06

SCOLR Pharma (AMEX:DDD)

$853.16

Total

$78,681.48

S&P 500 Total

$76,748.85

Still in the LeadHere's where it starts to get a little confusing. Malkiel's random theory argues that almost any method for picking stocks is better than what the pros deliver. Because of this, indexes are his preferred investment vehicle. However, despite a dreadful year for the ABC portfolio, losing almost 20% more than the S&P 500, it still is ahead of the index over the long-term. So the question you have to ask yourself is whether the remaining eight stocks (SCOLR Pharma is on its deathbed) can outperform the index.

Potential Hits and MissesAt the bottom of the pack, Alcoa and Citigroup are possible surprise hits. Their stocks are down 77% and 83% respectively in the past year, with little short-term potential (long-term could be a different story). Alcoa is expecting to lose money in 2009, returning to profitability in 2010. Why the big drop? Aluminum prices dropped by 50% in 2008, and sales virtually disappeared. If you have a two-year plus hold, the stock price is attractive right now. As for Citigroup, it's not logical that the Feds will let it go away, especially with such a big ownership position. Those two stocks currently represent about 5% of the total portfolio - there's nothing to lose at this point.

At the top, aircraft parts maker Barnes Group beat first quarter estimates by two cents (22 cents to 20 cents) on a sales decline of 32%. For the year, it estimates EPS between $1.20-1.35 on lower sales. At the current price, hitting the low end of its earnings range would mean a forward P/E of 12.5. Long-term, it should be fine.

Online learning software maker Blackboard beat Q1 EPS estimates by two cents, 27 cents to 25 cents. On May 6, its stock dropped 10% after it provided full-year EPS guidance of $1.21 to $1.38 a share on revenue of $365-375 million. At the bottom of its earnings range, it's trading at a forward P/E of 23, high until you realize 2009 EPS growth should be upwards of 50%. Education is hot right now, so this is the one most likely to be up in the next year. (For more on portfolio construction, check out Major Blunders In Portfolio Construction and A Guide To Portfolio Construction.)

The Bottom LineNone of the companies in the ABCs portfolio draws significant interest. Nonetheless, you can beat the indexes over the next year or two, if you're willing to stick it out. (For more on the random walk theory, see Financial Concepts: Random Walk Theory.)